The Tip of an Iceberg

Central Banks buying stocks

The new normal

Since I started learning about trading and markets a few years ago, I’ve often been wrong and flummoxed. Over time and in retrospect, I can usually figure out why things happened the way they did. But the goal in trading and investing, of course, is to anticipate.

I just recently learned that central banks have been buying stocks. A lot of them! This was not something central banks did before in their 100 year history. In the first half of 2017, I heard on the radio, central banks bought $1.7 trillion of stock!

I still have to develop some idea for how far this can go, and the likely results. I remember in 2009, when Obama and his banking insider Timothy Geithner announced their scheme to start printing $900 billion per year. “Quantitative easing.” It was jaw dropping in scale!

They printed over $4 trillion from 2009-2014, before shutting off the US printing spigots. That money (which had disappeared from real estate, and millions of peoples’ pockets as equity) flowed through the small % of the population who could get their hands on it, and in to stocks, bonds, and gold…making them all flow up together, which is historically abnormal. (Usually, they alternative, because, for instance, money is taken out of bonds, and put in to stocks, or out of stocks and in to gold, etc.)

Here is the run caused by the US central bank printing presses, as seen in the SP 500.

You can see how when the printing stopped, the market flattened, and looked ready to correct down. This happens to be right when I started studying markets.

Then, since the Trump election, we’ve had another bull run. But this one wasn’t fueled by the US central bank printing money. So I scratched my head about where the money was coming from, to keep driving the market up.

Of course, the European Union is still printing money. And for Japan they’ve been printing to keep their heads above water for many years. China also has a scheme for debt/money creation, but it primarily has been creating private debt, whereas the US and Europe are creating both public and private debt. Still, it’s a lot of new money from China. So all those things could have something to do with it.

One of the things one learns about auction theory, is that when you get an impulsive move, it usually continues. The impulse shows that the market is trying to revalue a product. The consensus of the market, and the biggest players, is that price should move to a different level.

However, since 2014, every time the market tries to break down, it doesn’t follow through, and gets bought right back up. This was really confusing to me. There was a joke going around that the central banks had a “plunge protection team.” I am not sure when it became public knowledge that this was in fact true. But you can see the result.

Each time the market tried to break down in 2015 and 16, it couldn’t follow through. And then in 2017, the big blue box around Trump’s bull run was driven by central banks buying $1.7 trillion in stocks.

Where will this take us next?

I have been posting charts and ideas for the past couple of years targeting the levels we are roughly hitting now as a natural ceiling. This is based on doubling earlier ranges, in the SP 500.

But in individual stocks, particularly the FAANG stocks (Facebook, Amazon, Apple, Netflix, Google), price has been blowing through all natural ceilings based on earlier ranges. This is presumably because central banks have been buying the shit out of them.

So the question arises, what is the limit to this kind of run?

In the short term, one would think the banks’ buying spree would end when they have fully invested the money they’ve already printed. Then possibly those downward forces (selling) that tried to exert themselves from 2014-2106 might finally actually get down draft follow through.

And since central banks are “price insensitive,” in theory they would not care about stock prices. They would not sell. Then would just start buying again, the next time they get an excuse to print more money.

When the US central banks printed $4 trillion, and the government spent it in to the economy, it created $4 trillion of assets on the banks’ books. They in turn, in the old fashioned banking business model, would like to relend that money privately to businesses and individuals, driving private sector growth, and more bank profits.

I had heard that banks were having trouble managing this. The economy was too weak to supply them with enough qualified borrowers. So apparently they came up with this new scheme.

If they buy stocks which provide 2 or 3 % dividends, it’s a similar return as if they lend money. (Except that buying stocks doesn’t create new money, like lending does. Still, it’s a good scheme, since the money on their books came out of thin air in the first place.)

They have also been buying corporate bonds. I had heard about that in the EU, and that was another jaw dropping moment for me, like the 2009 announcement of printing $900 billion per year in the US. Because, again, this was historically not considered acceptable banking practice. It represents banks hijacking normal free market practices.

In a normal free market, businesses should have to perform and show promise of performance, in order to attract investors to buy their bonds, giving them more funds to further grow their business. But if central banks are buying bonds, and central banks are “price insensitive” (meaning they can lose money with impunity, or print more money to prop things up ad infinitum), then they have a non-natural control over the business world.

The old money printing scheme was that the government borrowed money in to existence, then spent it in to the economy through government programs. In the new scheme, giant corporations can also borrow money in to existence (from central banks, as opposed to natural investors) and theoretically spend it in to the economy.

(A nuance that wrinkles up this scheme is that giant corporations like Apple, for instance, have a huge amount of money on their books, that is not being spent to grow the Apple business, but is reinvested in stocks and other things, which is part of the driver of their profit.)

So central banks and giant corporations become some of the main investors in the stock market. And these investments drive part of their profits. But none of these investments drive actual economic activities, which are needed to produce the profits, that justify stock valuations.

In the old days, the main investors in stocks were people, and people via giant mutual funds and hedge funds. These were the “big fish.” But they still acted like us little fish. They still wanted to get a good deal, and they cared about fundamental “value.” This is what drove the auction process, that technical traders learned to read.

Now, apparently there is a bigger fish in the pond. And this bigger fish (central banks), is not concerned foremost with getting a good deal. It’s a whole different kind of fish. Maybe it’s not even right to call it a fish. It’s like a fish farmer or something. It’s not just like a bigger version of us little fishes.

So when we look at things like technical ranges of price, and normal market behavior, we have to consider if these things are created by the minds and behaviors of fish (normal market participants), or if they are natural limits, phenomena built in to nature.

Like, if the market tops here, which happen to be a range doubling level, on various time frames, is that built in to nature, so it will just happen to coincide with the time central banks have bought all the stocks they want? Or will the fact that they have potentially unlimited resources (not a natural phenomenon) screw up the neat sensibility of markets?

Let’s say US central banks had a spare $4 trillion sitting around. And they have spent $1.7 trillion on stocks in the first half of 2017. They might also be buying corporate bonds, like in Europe. And they might want to keep some of those funds on hand for actual bank business, lending money in to existence.

So it’s possible that a top might form here anyway, which might just happen to correspond to saturation for now for banks buying stocks.

We really should have a way of analyzing what is possible and probable for central banks, in the same way fundamental investors like Warren Buffet have long used to analyze corporate health and profits.

And since activities of central banks that used to be obscured (like printing money) have become increasing explicit over the years, maybe there is or will soon be a way to look more in to banks’ books, to formulate investment guesses.